Services, servers to challenge HP, Compaq

But with complex product lines offered by the two companies and their young services effort, that aspiration could be hard to achieve.

A major part of HP's ambition is to give IBM "a competitor that's strong enough, bold enough, and talented enough to take them head-on in the enterprise space," CEO Carly Fiorina wrote in a letter to HP employees.

These "enterprise" customers--big businesses that sign multimillion-dollar computing contracts--are a picky but well-funded bunch. In some respects, the new HP will be well-positioned to take advantage of any opportunity that comes its way.

With Compaq under its wing, Palo Alto, Calif.-based HP will be one of the biggest makers of servers. Server sales typically open the door to consulting contracts, storage system sales and software licenses.

"Their respective services businesses are highly regarded," said Mark Romanowski, senior vice president of client services and business development at AMC, a New York-based systems integrator. "The problem is that they will have to do a much better job marketing their capabilities, being less bureaucratic and inclusive of their partners."

Absorbing Compaq, though, won't be easy. Compaq bought Digital Equipment in 1998 for its services group, and Compaq's transition to a consulting power has only just begun, according to various analysts.

"It took IBM 20 years to make it a profitable business," said Robert Frances Group analyst Ed Broderick. "IBM's tens of thousands of consultants can outgun HP's 15,000 any day."

The merger "seems to be such a daunting task," said Gary Griffiths, CEO of Evergreen, which specializes in a subscription-based PC management service. HP is an investor in Evergreen.

Services: Key market
HP has long been trying to improve its services business. It failed in November to close a deal to acquire PricewaterhouseCoopers for about $18 billion and since then has been emphasizing smaller partnerships with Accenture and PwC.

The merger creates an in-house consulting group, but it's dwarfed by IBM's. In their most recent quarters, IBM received $8.7 billion--40 percent of its total revenue--from consulting services, while HP received $1.8 billion, or 15 percent of its total revenue, and Compaq had $1.7 billion from services, or 20 percent of revenue.

However, the services revenue from HP and Compaq chiefly derives from providing maintenance work, not the more profitable consulting contracts IBM often signs with companies that want to revamp their computer operations.

HP and Compaq have a total of 65,000 services employees, but about 40,000 are relatively unsophisticated repair people and 10,000 run outsourced computer operations, according to Broderick. That leaves about 15,000 in more lucrative consulting work.

Terry Shannon, author of the Shannon Knows Compaq newsletter, said the acquisition is a good idea, but the combined company will have to bolster its consulting staff. "Clearly, where the growth opportunity is going to be is in the professional services space; they're going to have to hire more people or retrain some of their break-fix people," Shannon said.

Another potential pitfall lies in competing with existing consulting firms. Last year, HP's Unix server sales were dented by competition between HP sales representatives and HP dealers.

To solve the problem, HP imposed what it called a "hard deck." HP would sell servers directly to Fortune 1,000 companies; resellers would sell to the rest of the world. Some HP sales reps were also let go by the company, Mark Hudson, worldwide marketing manager for the business systems organization at HP, said earlier this year. HP may impose similar measures in its services strategy.

Overall, HP tends to get fairly high marks from its network of integrators and dealers. Unlike Compaq, HP has placed less emphasis historically on direct sales. Compaq's dealer authorization programs could also be confusing and time consuming, according to Kenneth Catto at Pro-Desk Internet Business Consultants, which provides computers and networking to small businesses.

IBM isn't the only competitor for HP, either. Sun Microsystems also has been boosting its services business, with annual revenue growth slowing from 40 percent to 50 percent to the mid-20 percent range in the most recent quarter, Chief Marketing Officer John Loiacono said. "It's the only area we're still investing in over the last two quarters," he said.

Still, Sun could lose out to combined services efforts by HP and Compaq. "Sun is playing catch-up from a service and support standpoint," said Henkel Associates researcher Tom Henkel. "Now with these two entities combined, Sun starts to look mighty pale in terms of worldwide coverage."

Contemplating servers
Sun, as well as IBM, Dell Computer and storage maker EMC, looks stronger when it comes to servers and the pain HP and Compaq will endure sorting their product lines out, Eunice said.

"If I were IBM or Sun or Dell, companies that have their act together, I would be dancing in the streets," said Jonathan Eunice, a consultant at Illuminata. "You're talking at least a year to two years of internal navel-gazing and dislocation as all these issues get sorted out."

IBM is the top server maker, with 24 percent of the worldwide revenue for the first quarter of 2000, said IDC analyst Vernon Turner. HP, with 17 percent, is in second place, while Compaq, with 16 percent, is in third. But several say customers could move away from HP and Compaq during the acquisition period, eroding what could be the top share of the server market.

"There's going to be a lot of stall in the market," said Broderick. "If you're an information-technology executive with an installed base of Compaq servers looking at a Compaq proposal, I'd question whether you'd sign it today."

Gartner analyst George Weiss says the HP-Compaq deal seems to make sense in at least one area: consolidating the two companies' respective server designs and strategies. see commentary

Likely winners will be Compaq's ProLiant line of Intel servers, which are faring better than HP's competing NetServer products, and HP's 9000 series of Unix servers, which are farther down the path of conversion to Intel's Itanium chip than Compaq's Unix servers.

But HP and Compaq can't just dump willy-nilly those projects that don't fit into the long-term strategy: High-end customers demand that servers be supported for years after they're purchased.

It's nearly impossible to phase out older server technologies because customers use them for years, said Robert Frances Group CEO Cal Braunstein. "These things were always supposed to be dead yesterday," yet they linger on, he said.

"Take how long it took Compaq to shoot Alpha," the chip at the heart of its Unix server line until the company shifted its designs to Intel's Itanium, Henkel said. "If they put the money invested in Alpha in a passbook savings account, they'd have a half-billion dollars just sitting there. Stuff like that, HP needs to reconcile quickly."

The acquisition has long-term potential, though, Henkel said. And it will shorten the list of companies battling for top-end customers, said Technology Business Research analyst Brooks Gray.

"The new company and IBM will basically own the glass house," the tightly controlled data center where a company's most important computers reside, Gray said.

News.com's Michael Kanellos contributed to this report.